Deal Structures
Every company is different and, as a result, the sale of every company is unique. Each sale requires a bespoke governing sale and purchase agreement to spell out with clarity what the responsibilities of both buyer and seller are.
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Deal Structures When Selling Your Business
There are two common approaches used to purchase a business and five common ways of paying for a business. When taking your company to market, you must decide in advance which type of sale and which methods of payment are acceptable to you and try not to deviate from them. Conflict and disagreement during both the negotiation and due diligence phases of the acquisition of a company are to be expected – after all, both sides are trying to secure the best deal for themselves and they are behaving accordingly.
But knowing in your own mind beforehand what is right for you and what isn’t right for you will give your negotiation approach urgency and credibility. And throughout the process of selling, your acquirer and their professional representatives will quickly understand what is acceptable to you and what is not.
Types Of Sale
With an asset sale, the acquirer selects the assets they wish to purpose – generally included in these types of sale are plant, property, IP, contracts, goodwill, and so on. You remain the owner of your company and your company still owns its liabilities. These deals go through a lot quicker than share sales because they are less complicated and because the acquirer is not taking on the types of risks and liabilities they would be taking on if it was a share sale.
The tax surrounding asset sales can be fraught so you would benefit from speaking with your accountant before making a decision
With a share sale, you sell everything – the shares in the company, everything the company owns, everyone the company employs, every supplier relationship you have, and all of your company’s contractual obligations. They take the good and the bad. For example, on a share sale, every finance facility your company has agreed to, like a commercial mortgage or a working capital loan, must be paid off in full prior to the sale. Very few finance companies allow a company to novate an outstanding finance agreement to a new owner.
Due diligence requirements on share sales are generally very high because every aspect of the business needs to be examined to prevent the acquirer from purchasing something different than they expected.With a share sale, your company is normally bought by another company with a trading history and assets of its own or by a non-trading special purpose vehicle (SPV) with no assets of its own.
Should the deal sour post completion, you will have a much greater chance of success in securing any money you’re owed if your business was bought by a functioning, trading company. If you have to pursue an SPV for payment, the chances of recovering any outstanding payments are usually next to zero.
Paying For The Deal
As a rule, the higher the initial payment, the lower the amount of money you’ll receive for your company. Most takeovers are financed by debt and, in the months following the takeover, a new company within a group may drain cash for the new owner and distract his/her senior management away from their normal duties.
However, as mentioned earlier, there is no guarantee that, if you allow payments to be deferred, that your old company (or the new company taking it over) will survive for long enough to make those payments. You should also be wary of “completion accounts”. Your acquirer may want the price lowered if the value of your company (measured by its assets minus its liabilities) is lower than a given amount on the day of completion (the day on which the shares or assets are sold).
Completion accounts are generally finalised within 90 days of the deal being done and, if the value of the business is lower, you will usually be expected to reimburse the acquirer using an agreed method. You should ask your professional representatives (your solicitors and accountants) to argue that the lowest value possible be included in the sale and purchase agreement to protect yourself once the price has been agreed.
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five general ways for your acquirer to pay you
A 100% Cash Payment
Deferred Consideration
An Elevator Deal Structure
Contingent Deferred Consideration
Seller Financing Structure
Acquirer Payment Types
Now that we have mentioned the 5 different ways in which you can get paid for selling your business, we will go into more depth of each type.
With a 100% cash payment on the day of completion, you have certainty about the amount of money you’re going to receive.
This type of sale will however lead to your receiving the smallest amount of money in principle out of all five types of sale. We say “in principle” because of the caveat mentioned above that the acquirer might make a mess of the takeover and you may end up receiving more in total using this payment method than by using another if they do make a mess of it.
With deferred consideration, you receive an initial consideration (the payment on completion) and you are then paid according to a schedule thereafter. The thinking behind deferred consideration is that your acquirer will be able to pay you more because they will be able to fund those payments from the profit and cash flow generated by your old business.
With deferred consideration, the date for each tranche of payment will be set out in the sale and purchase agreement together with penalties for non-compliance. These penalties are rarely enforced though to keep the acquirer onside and they are generally unenforceable if your company was acquired by an SPV.
An elevator deal is a complex arrangement where you retain minority ownership and when you wish to be involved in the business still and continue to draw a salary.
Elevator deals are generally offered by equity investors who want to sell your company on again in 5-7 years’ time and who believe that your continued presence within the business is required to maximise growth and their return on a future sale.
Contingent deferred consideration deals, sometimes called earn-outs, also pay a seller in instalments but, other than the initial payment for a set amount, future amounts are determined by whether or not the company has hit targets agreed in the sale and purchase agreement. Earn-out tranches may be settled by cash, by the allocation of shares in the acquirer’s company, or both.
Earn-out deals are very contentious because the previous owners lose decision making authority and the decisions made by the acquirer and their management team may actively prevent a target being hit. An acquirer might insist on an earn-out, even if yours is a high-growth company, because they are concerned that too much of the revenue generated by a business is because of your presence.
These deals, in and of themselves, are not bad and you should certainly consider them. However, you should build protection in for yourself into the sale and purchase agreement with regards to the power to make decisions and on the accounting methods used in calculating whether a target has been achieved or not.
Seller financing is far more common in the USA – there are signs of it growing in popularity in the UK but those signs are not particularly strong yet. With seller finance, your acquirer pays you a small sum of money on completion. You then lend the acquirer money to purchase your business. You charge interest on the loan which is repaid monthly until the agreed full amount is paid off.
The loan agreement between you and the acquirer is legally binding. Contained within that agreement is the facility to “repossess” your business if the acquirer does not keep up with the repayments. If it does come to that though, you’ll probably be walking back into something that is in a far worse state than you left it.
With seller finance, you can negotiate a higher price for the business and you receive a regular monthly payments similar to a salary following completion (subject to the acquirer being able to make these payments). There may also be tax advantages to this method particularly with the recent changes to Entrepreneurs’ Relief but we strongly advice you check with your accountant prior to making any decision.
